Sunday 11 December 2016

Could this run of record low interest rates last until 2020?

Published 19/04/2015 | 02:30

Irish savers could have several more years of dismal investment returns ahead of them - a leading economist has warned that it could be ages before interest rates start to rise again.

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"Low interest rates are being driven by low inflation," says Alan Ahearne, professor at NUI Galway who was also special adviser to the late minister for finance Brian Lenihan. "The European Central Bank inflation target is just below 2pc. We've still some way to go to get to that and we're unlikely to see inflation come back to 2pc in Europe in the near future. So central banks won't be in a rush to raise interest rates. It could be several years before European interest rates increase again."

As Europe faces deflation, consumer prices are falling rather than rising. Last month, prices in the eurozone fell by 1pc.

Last Wednesday, the ECB voted to keep the key interest rates across the eurozone at record lows. European interest rates have been at all-time lows since January 2009 when the ECB cut its benchmark rate - the rate that has a direct impact on the mortgage repayments of borrowers with tracker mortgages - to 2pc. This rate has been slashed to 0.05pc since - and that rate was left unchanged last Wednesday. One of the main reasons interest rates are kept low is to encourage consumers to spend, which in turn should help stimulate an economy.

This run of record low interest rates isn't unique to Europe. Interest rates have been at record lows in the United States and Britain for the last few years.

Earlier this year, Bank of England's chief economist, Andy Haldane, said it could be 2020 before British interest rates start to rise again.

The top American economist Larry Summers has argued that America could have decades of stagnation ahead of it - if he's right, low interest rates and slow economic growth could become the norm there. Some commentators have even gone as far as to suggest that interest rates might never rise again.

But Mr Ahearne describes predictions that interest rates might never rise again as "very speculative".

"These are extraordinary lows but interest rates will rise at some stage," says Ahearne. "It's really a timing issue and very much depends on economic data. If we get unexpected economic growth in Europe, interest rates could go up sooner than expected but at the moment, there's no sign of that robust recovery. The European economy is very weak. There is no pricing power so businesses aren't able to push up their prices."

At last Wednesday's ECB press conference, which was briefly suspended after a protester threw paper at Mario Draghi, the bank president insisted that the ECB would stick with its quantitative easing (QE) programme - the term used to describe a central bank's decision to print money - until September 2016. So at the very least, it looks like we have another year-and-a-half of low interest rates ahead of us.

"The ECB would have to stop QE before interest rates go up," says Ahearne.

So who are the winners and losers in this run of record low interest rates?

Losers

Savers have clearly borne the brunt of low interest rates over the last few years.

Eight years ago, you could have earned about 5pc interest on a deposit lump sum of €10,000. That's more than three times what you can expect to earn on a similar lump sum in a better-than-average deposit account today - unless you're happy to tie up your money for ten years in the State Savings' 10-year National Solidarity Bond, which even then, only pays 2.26pc interest a year. Furthermore, the tax that savers must pay on savings interest today is more than twice that paid in 2008.

Those about to retire have also fared poorly.

"Low interest rate environments are toughest on people closer to retirement or lower risk investors," says James Costello, head of Davy's global portfolio strategy funds. "As you approach retirement, you tend to reduce the risk of investments and go into what are thought of as 'low-risk' investments. These usually include bonds and cash. Low interest rates mean bond and cash yields are low and so your investment return is low. Cash rates today are less than 1pc."

Interest rates are usually low when inflation is low - or when an economy is in the midst of deflation. Although consumers might benefit from low prices, they can lose out in the workplace. "Falling prices are bad for overall economic activity and can lead to job losses," says Mr Ahearne. "Pay rises are also less likely."

Winners

Investors in commodities, equities and property usually do well when interest rates are low, says James Costello.

"Assets that have substance and hold their real value as inflation increases, such as property and commodities, do well," he says. "One of the reasons equities can do well is that corporates can borrow more at a low interest rates and invest it in operations."

The hundreds of thousands of borrowers with tracker mortgages are probably the biggest winners. With the ECB base of 0.05pc, the interest paid by tracker holders could be easily below 1pc, depending on their lender. That's less than a quarter of the rate charged to those taking out a mortgage today. Trackers are no longer available to new borrowers today.

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